Tear down the trade-policy silos! Or how the servicification of manufacturing makes divides in trade policymaking irrelevant

Magnus Lodefalk16 January 2015

The manufacturing sector in OECD countries increasingly buys, produces, sells and exports services. This is now known as the servicification of manufacturing. This column, using firm-level data from Sweden, shows that as firms’ share of in-house services increases, so does their export intensity. The increasing complementarities between services and trade in goods thus imply that the different trade policies for goods and services are an antiquated divide.

The state of manufacturing in OECD countries and its offshoring to emerging economies have been concerns for a least a decade but nowadays the industry has been considered the comeback kid. Policymakers in OECD countries seem to hope for a renewal of manufacturing that will strengthen their industrial base (e.g., European Commission, 2014). As an example, the new prime minister of Sweden, Stefan Löfven, has set out to reindustrialise the country and make it the world leader in manufacturing, this as part of the strategy to make the unemployment rate the lowest one in the EU by 2020 (Schück, 2014). A trend related to these aspirations is the servicification – the increase of purchases, production, sale and export of services – of manufacturing. This column briefly summarises the micro-level evidence, continues with trade effects, and ends with implications for trade policy.1

Servicification of manufacturing

Servicification is arguably a game-changer for manufacturing. The trend is evident across OECD countries and manufacturing industries (Pilat 2005, Pilat et al. 2008). For example, in Lodefalk (2013) I used input-output data for Sweden and found that the share of services in total inputs has doubled in the 1975-2005 period. Using micro-level data that considers the reorganisation of manufacturing firms into enterprise groups and industrial reclassification of activities, I find that manufacturing has not declined as much as previously considered. More importantly, manufacturing increasingly buys, produces, sells and exports services. Today, manufacturing industries account for major shares of exports of services. In Sweden, the telecom industry is the second largest exporter of services after the transport industry (Growth Analysis, 2010). Subsequent studies find similar patterns of servicification for Germany and France (Boddin and Henze 2014, Crozet and Milet 2014, Kelle 2013, Kelle and Kleinert 2010). If the value-added of the services industry to manufacturing is considered, services accounts for approximately 50% of gross exports of the EU and of the US (OECD, 2014).

Arguments for servicification

There are several potential reasons why manufacturing firms may want to focus more on services, besides the basic fact that some services such as transportation are essential for foreign trade (Lodefalk 2014). First, services may help firms to become more productive, for example, through the use of services in logistics, management or engineering that save time, materials and improve coordination (Nordås, 2010). Second, in the presence of fiercer foreign competition, firms may differentiate their offers by adding services to products, bundling them with products, or offer them in connection with the sale of manufactures. In this way, they could also attune to changes in demand towards services and the environmental and social aspects of manufactured goods. Third, firms may use services to overcome informal barriers to foreign market entry and to sustain foreign market sales. Examples of such services include interpretation of foreign languages, matchmaking and monitoring services. In addition to these motives, manufacturing firms need services to establish, join and manage international production networks and value chains. Services are enablers of such networks and value chains.

Empirical evidence on trade effects

Empirically, there are few studies on the effects of servicification on the foreign trade of manufacturing. Most of the previous work is uses macro- or industry-level data to study selected services - such as business services - and trade. In Lodefalk (2014) I regress manufacturing firm exports-intensity in Sweden on the share of services in in-house production and the share of purchased services in output, using a fractional and censored estimator while controlling for firm, industry and year specificities. I find stylised premia in terms of exports and productivity for firms that have a larger share of services in in-house production. The final econometric estimate confirms that the higher the share of in-house services, the higher the export intensity of firms. The strongest links are between the hiring of managers and professionals and exports.

We may get a complementary perspective by studying evidence on the impact of import of services or barriers to such import on the trade of manufacturing. Nordås and Rouzet (2014) and Pasadilla and Wirjo (2014) exploit the new services trade restrictiveness index of the OECD and bilateral trade data. They find that restrictions on the import of services are associated with less trade in manufacturing. Interestingly, the negative association with trade is twice as strong for exports of manufacturing compared with for services. Miroudot et al. (2011) look at cross-border trade in services and find that regulatory reform can substantially reduce barriers to trade in services. They estimate current ad-valorem barriers to trade to be in three digits for services and almost twice as large as for goods. Graneli and Lodefalk (2014) compute the distance to best practice in terms of openness to import of services through the temporary movement of persons (Mode 4 of supply). They show that there is ample scope for improvement towards the country that is "best in class". Moving on, they study the relation between cross-border movement of persons and the exports of firms in Sweden. The econometric results suggest that a firm’s hiring of recently arrived persons from abroad is positively associated with the firm’s subsequent export to their origin country (National Board of Trade 2015).

Trade-policy implications

In a nutshell, there are good reasons for why manufacturing firms servicify and yet there are substantial formal and informal barriers to trade in services. An illustrative metaphor may be that services trade liberalisation so far has been the stepchild of the international trading system. The neglect of services was not originally envisaged for the predecessor to the WTO – the GATT – and the dismal and separate treatment was not inevitable when trade in services were potentially to be negotiated in the 1980s. Although some progress has been made since then, services do still appear to come off as the losers in trade negotiations, which employ separate tracks for negotiations on manufactures and services. Today this treatment is a harmful relic from the forming years of the international trading system.

Another antiquated divide is the one between offensive and defensive interests in trade policy. With trade in goods being dependent on both imports and exports of services and with international value chains, the offensive interest of countries is not to be defensive but to open up at home while seeking openings abroad. Low tariffs on goods are simply not enough for the internationalisation of servicified manufacturing firms.

To underpin and inform modern policies on foreign trade in services, governments need to sound out the views also of manufacturing firms and of small and medium-sized enterprises. Consultations with manufacturing and SMEs in policymaking on trade in services may well to lead to shifts in the prioritisation of services sectors, barriers, and modes of supply (National Board of Trade, 2012). For example, large firms may handle and even benefit from non-tariff formal and informal barriers to trade. But SMEs rank such barriers as more trade restrictive than transport and tariff costs. Moreover, SMEs are contributing non-trivially to foreign trade but are likely to be less listened to in policymaking (Cernat, 2014). There are also some indications that new firms contribute to the servicification of manufacturing (Crozet & Milet, 2014).

To unleash the foreign competitiveness of manufacturing firms, countries also should pay more attention to cross-border movement of persons, for example through Mode 4 liberalisation of trade in services. Case studies and business surveys highlight the importance of movement of persons for firms and trade ( Cernat 2014, Harvard Business Review 2009, National Board of Trade 2013). The National Board of Trade (2015) concludes that liberalisation in this area is a win-win and that even unilateral opening up for cross-border movement of persons would beneficial from an export perspective. Countries should therefore also consider improving processes related to visas and work permits to become more competitive.

A final proposal worth considering is to add a fifth mode of supply (Mode 5) to international trade rules and negotiations on services (Cernat and Kutlina-Dimitrova, 2014). Servicified manufacturing means that services may carry custom duties on manufactures, for example software installed in the product before export, although services are exempted from duties if they are provided cross-border. The extra tariffs raised are not likely to be trivial.2

Concluding remarks

To conclude, governments still have an important role to play to facilitate the trade of manufacturing firms. However, their efforts need to realign with the changing nature of manufacturing. The historic divides in policymaking between trade in manufactures and services, and between offensive and defensive interests are largely antiquated. More research is also needed on the role of services for manufacturing firms, including in developing countries, and its implications for trade policy. A research agenda would likely include how firms bundle goods and services, their complementarity in trade, how servicification effects on trade margins and how firms handle duties on services that are embodied in manufactures or embedded in their sales.

Cernat, L and Z Kutlina-Dimitrova (2014), "Thinking in a box: A 'Mode 5' Approach to Services Trade", Journal of World Trade 48(6), 1109-1126.

Crozet, M and E Milet (2014), "The Servitization of French Manufacturing Firms", CEPII Working Paper 2014-10.

European Commission (2014), "For a European Industrial Renaissance, Communication from the Commission to the European Parliament, The Council, The European Economic and Social Committee and the Committee of the Regions", (COM/2014/014 final). Brussels.